Fiscal Centralization: Theory and Evidence from the Great Depression

The Great Depression produced a profound and lasting influence on the structure of U.S. government. We study theoretically and empirically the increased centralization of revenue collection and expenditures in the hands of the states relative to local governments during the 1930s. In our political-economy model the income decline of the Depression causes a rise in property tax delinquency, undermining the main source of revenue for local governments and leading to increased political support for sales taxation and centralization by the states. Empirical evidence based on cross-state variation in the severity of the Depression is consistent with the model's key predictions.